We all have 24 hours in our day. Most of us spend somewhere between 8 and 12 of these hours at work. It is vital that we are as productive as possible with this time – that is, that we get the most benefit (i.e. corporate profit) out of each hour.
In recent months, I’ve seen several articles concerning finding “gold” in your dead and excess inventory – that is, your stocked products that haven’t sold for a certain length of time (usually a year). These articles say that if you just use the Internet and other creative ways to find willing buyers, you will greatly enhance your company’s net profit. Some have even gone so far to say that this process should be made a top priority for your company.
Well, it’s true that turning excess inventory into cash is good. But before you put considerable effort into a dead stock liquidation program, be sure that you are currently “buying right” – that is, be sure you are ordering the right quantities, of the right items, at the right time.
To show you how “buying right” does more for your profitability than liquidating dead stock, we’ll look at an example. We ranked the items for one of our distributors. The ranking process identifies those products that provide the most opportunity for your company to earn a profit. We begin the process by sorting all stocked products in a warehouse in descending order, based on cost of goods sold (COGS) during the past 12 months.
Those products that are responsible for 80% of sales are assigned to rank “A.” The items responsible for the next 15% of inventory items receive a “B” rank. The next 4% of items are assigned a “C” rank, and those responsible for the last 1% of sales receive a “D” rank. Products with no sales (i.e. dead stock) receive the rank of “X.” Here are the results (note: numbers rounded to provide clarity):
| Rank | #Items | %Total | COGS$ | %Total |
| A | 2,000 | 13% | 8.0 Mil | 80% |
| B | 3,000 | 20% | 1.5 Mil | 15% |
| C | 4,000 | 27% | 0.4 Mil | 4% |
| D | 4,500 | 30% | 0.1 Mil | 1% |
| X | 1,500 | 10% | No Sale | 0% |
| Total | 15,000 | 100% | 10.0 Mil | 100% |
Note that 13% of the products (the “A” ranked products) generate 80% of the warehouse’s $10,000,000 in sales. The remaining 87% of products generate the remaining 20% of sales. Here is the inventory turnover the distributor experienced before implementing more effective replenishment methods:
| Rank | COGS$ | Avg Invty | Turnover |
| A | 8.0 Mil | 1,666,667 | 4.8 |
| B | 1.5 Mil | 500,000 | 3.0 |
| C | 0.4 Mil | 222,222 | 1.8 |
| D | 0.1 Mil | 166,667 | 0.6 |
| X | No Sale | 163,121 | 0.0 |
| Total | 10.0 Mil | 2,718,677 | 3.7 |
They were experiencing 3.7 annual inventory turns per year. Their average gross margin was 24%. Return on investment (ROI) is defined as annual turnover multiplied by gross margin percentage. This distributor was experiencing an ROI of 88.8 (3.7 turns x 24%). This is a return of approximately 89 cents for every dollar invested in inventory.
We weren’t satisfied with these results. We immediately scrutinized how the distributor purchased the 2,000 “A” ranked items. We found that, due to inaccurate demand forecasts and unusually high safety stock quantities, they were buying too much of these products at the wrong times. This meant that these items were often overstocked, but replenishment shipments weren’t received until stock was entirely depleted. We implemented effective ordering controls and over a period of three months, and the value of “A” ranked items decreased from $1,666,667 to $1,333,333 (a reduction of $333,334):
| Rank | COGS$ | Avg Invty | Turnover |
| A | 8.0 Mil | 1,333,333 | 6.0 |
| B | 1.5 Mil | 500,000 | 3.0 |
| C | 0.4 Mil | 222,222 | 1.8 |
| D | 0.1 Mil | 166,667 | 0.6 |
| X | No Sale | 163,121 | 0.0 |
| Total | 10.0 Mil | 2,385,343 | 4.2 |
Turnover for “A” items increased to six annual turns and overall turnover increased to 4.2 turns per year. As a result, return on investment increased from 89 cents to $1.01 (4.2 turns x 24% gross margin) for every dollar invested in inventory.
Had we eliminated all of the dead stock instead of concentrating of increasing the turnover of “A” items, overall inventory would have only increased to 3.9 turns per year:
| Rank | COGS$ | Avg Invty | Turnover |
| A | 8.0 Mil | 1,666,667 | 4.8 |
| B | 1.5 Mil | 500,000 | 3.0 |
| C | 0.4 Mil | 222,222 | 1.8 |
| D | 0.1 Mil | 166,667 | 0.6 |
| X | No Sale | 0 | 0.0 |
| Total | 10.0 Mil | 2,555,556 | 3.9 |
The ROI would have only increased from 89 cents to 93.6 cents (3.9 x 24% margin).
The result: We experienced a greater increase in profitability from paying more attention to the “A” ranked items than we would have in liquidating our dead stock. And there were other advantages to this action plan as well:
- We freed up $333,334 (valued at full cost) in working capital. It is doubtful that we will receive our full cost for the dead stock ($163,121) when it is liquidated. Chances are good that we will dispose of a good deal of this dusty inventory for less than our cost.
- The customer service for “A” ranked items actually increased. Why? Because the distributor’s buyers were giving extra attention to these critical items that comprise 80% of the total sales volume.
Sure, liquidating dead stock is important. But it probably won’t contribute as much to your overall profitability as the process of ensuring that you are buying the right quantities of fast-moving products at the right time. This distributor has a long way to go to achieve his inventory-related goals, but he’s off to a good start.
See our most current post and our new book, “Achieving Effective Inventory Management,” for ideas on how to optimally set the replenishment parameters for stock items.